Prepayment risk represents, in essence, the value of goods or services that have been paid for using a credit card but the service or goods are to be supplied at a future date. Typical customers who may present such risks include airlines, travel agents, hospitality, education, insurance, retailers who permit lay buys or any merchant that receives payment prior to providing goods or services. The scenario is, for example, that consumers purchase concert tickets from a merchant customer of a bank, to whom a credit card facility is provided. In the event that the consumer does not receive the service for which they paid, for example in the case where the concert is cancelled, then the merchant, or if he is unable to reimburse the consumers, the merchant's bank (the acquiring bank) is obliged to reimburse the consumers, via their card issuer, for their purchases and charge this cost back to the merchant.
As such, banks may have a regulatory and/or other obligation to establish policies, systems and procedures for measuring, managing and reporting liquidity to ensure sufficient liquidity is maintained to meet their obligations arising from credit card transactions—that is to the extent of their Merchant Prepayment Exposure. Each bank has developed systems independently to measure, manage and report this exposure.
Merchant acquiring banks have typically estimated this based on regular historical reviews performed by bank staff. Banks have conventionally estimated a customer's prepayment risk by manually applying factors to the customer's sales data. In one form, annual turnover figures and an estimate of the percentage of prepayment sales may be used to assess annual exposure. Based on this estimate of exposure, the bank then determines a security deposit the customer is required to lodge to cover the assessed exposure (which may simply be a portion of an existing security).
These ad hoc manual processes are time consuming, and expose the bank to inaccuracies in its periodic risk calculation, which could lead to potential revenue and reputation risk. Further, this process may be deemed to have breached applicable regulations if inadequate measuring, managing or reporting is demonstrated. The actual quantum of exposure will vary based upon the merchant's actual trading experience, however this is not captured accurately by the existing processes.
Once an institution has established a merchant account, and thereby commenced providing acquirer services for a customer, in many cases it has no ongoing visibility of the card prepayment component which is being processed through the facility, or the potential third party risk associated with fulfilment partners such as airlines, hotels, tour operators and promoters.
A problem associated with conventional processes is that they cannot be demonstrated to accurately and consistently reflect the actual prepayment exposure. In most cases, the conventional assessment will lead to either an inadequate security deposit, which exposes the institution to greater than desirable risk, or an over-estimation of prepayment risk, placing an additional impost on a prospective client's working capital position, and on the competitiveness of the institution's services.
In view of the foregoing, it may be understood that there may be significant problems and shortcomings associated with current methods and systems for measuring, managing and reporting merchant prepayment exposure.